Hoping summer sheds light on markets

Commentary: Look for fundamentals in new season

By

ZacharyKarabell

NEW YORK (MarketWatch) -- One of the many blessings of June -- in addition to the beginning of summer, the end of the school year, and more hours of daylight to illuminate our anxieties -- we have the relief of no longer having to hear the phrase "sell in May and go away."

The old investing adage (cliché) isn't without some statistical validity. Over the past 50 years, the returns for stocks between May and September have averaged a paltry 0.84%. But in any given year -- and for the last five years the gains for the summer months have been in excess of 3% -- the returns vary so widely that the average is ultimately as useful as any other average for investing, which is another way of saying that it's useless.

Given what's transpired over the past nine months, however, the adage may constitute good advice, not from an investing perspective but in terms of mass psychology. We've recently expended so much collective energy on the global economic crisis and the vertiginous decline of stocks through mid-March that we may need a break in order to preserve collective mental health.

Trading activity is already down, as is volatility, which indicates that panic has subsided but excitement has not taken its place. And while many will turn to the pleasures of summer, with unemployment still on the rise and concerns about wages and jobs still high given the cascade effect of the General Motors Corp.
GM, -2.10%
bankruptcy, a good number otherwise inclined to go away over the summer can't or won't.

But if you still have money to invest and plan one day to retire, the coming months may offer a chance to take stock -- literally. For those who take the market pulse, there is a distinct sense that activity will be muted and, until late July at least, so will the news flow.

Little excitement

The bankruptcy of GM was so telegraphed that the actual news was unlikely to constitute a shock. Barring the usual unforeseen international crises, there is little to suggest much excitement in the coming weeks.

The result is that the markets are poised for a pause in the sharp run-up since the lows of March. While there are fewer signs and fewer fundamental reasons for a steep pullback, it is reasonable to anticipate a sideways market for the next few months, perhaps ranging from the high 7000s to the high 8000s for the Dow.

If that proves wrong, the risk is on the upside, especially since earnings for most companies have already bottomed and most people or institutions that had to liquidate their holdings in a fire sale have already done so. Fear of being too early in or of missing out has been a significant factor in the 2000-point gain on the Dow since March. Summer, however, should be a time for fundamentals.

We've already seen activity percolating globally, especially in areas of the world that have weathered the storm comparatively well such as Brazil and China. With the victory of the reform-minded Congress Party in India, the massive potential of the subcontinent may start showing some realization.

True, many industrial stocks as well as base metal companies have shown substantial gains of late, but not all have rebounded equally, nor has the recovery of infrastructure and base metal companies approached their highs of last year. Any pullback in those sectors is an opportunity to get. The collapse of capital spending on new supply combined with the same production and transportation bottlenecks that led to a spike in prices in 2007 and 2008 will mean that prices have only begun their ascent.

Hunt for the irreplaceable

The basic principle should be to look for companies that are providing goods and services that are irreplaceable. Any high-end steel company operating in the developed world, for example, faces stiff pressure from steel manufacturers in India or China.

While local demand will always matter, the cost advantage is simply too great to overcome. It provides goods that are not only replaceable by another company, but by another company at a lower cost. But any company providing raw inputs to industrial demand or specialized services, whether for oil fields, base metals, green infrastructure or power grids, is in a position to take advantage of demand.

In the United States, there are pockets of domestic strength even in the midst of an economy that when it recovers will likely show less growth than optimists now expect. Brands and goods that are unique -- such as the phone that rhymes with "eye" -- have been doing just fine during the recession and may soar as activity picks up.

Companies aiding in more efficient delivery of health care or lowering its costs, those providing high-end, desirable communications devices or entertainment, and firms that service the more modest needs of middle-class consumer all have seen a trough in their revenues. While they're unlikely to return to the debt-fueled glory of a few years ago, there is still considerable upside from here.

With financial institutions, credit-card issuers, HMOs and companies geared to the ultra-rich, the risks seem almost prohibitive. Someone will trade those names well, and more power to them, but many more will find only sadness and pain.

Finally, too many pundits obsess over discovering the correct market multiple. It's an impossible task; better to stick with what drives individual companies. At some point in the coming weeks, analysts and investors will begin to value their companies on earnings for 2010, rather than 2009.

Markets aren't pricey

Even on a pure forward 12-month basis, the markets are hardly pricey, especially given the non-existent level of inflation. Even with rates heading back up, interest rates are low by any historic standard, which makes stock that much more attractive in terms of potential returns.

As the smoke clears, there will be no shortage of autopsies about what happened, but for stocks, two things are evident: the selloff was one-part based on deteriorating business conditions and two-parts based on what was happening in the global credit system. Oddly, stocks sold off in the fall and into this year because equity markets were the most functional and liquid source of capital in the world. That should give some indication about the viability of stocks as an investment.

These markets can still burn anyone, and more nimbleness is required than ever before. Those who question the old strategy of long-term buy and hold are onto something. In a fast-moving world, long-term isn't as long as it used to be.

But for those willing to take the time and effort to find good fundamentals in a global economy that has suffered a blow and is about to resume robust expansion, this summer is as good a time as any. So go away, but take your computer, along with Wi-fi and Bluetooth.

Zachary Karabell is president of River Twice Research ( www.rivertwice.com ), a former mutual-fund manager, and author of "Superfusion: How China and America Became One Economy and Why the World's Prosperity Depends On It." to be published by Simon & Schuster this fall.

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